variable cost

Examples of variable cost in the following topics:

• Types of Costs

  • It consists of variable costs and fixed costs.
  • Total cost is the total opportunity cost of each factor of production as part of its fixed or variable costs .
  • In the long run, the cost of all inputs is variable.
  • Economic cost is the sum of all the variable and fixed costs (also called accounting cost) plus opportunity costs.
  • This graphs shows the relationship between fixed cost and variable cost.

• Defining Operating Leverage

  • Operating leverage can be defined, simply, as the degree to which a firm incurs a combination of fixed and variable costs.
  • Specifically, it is the use of fixed costs over variable costs in production.
  • For example, replacing production workers (variable cost) with robots (fixed cost) .
  • These include the ratio of fixed costs to total costs, the ratio of fixed costs to variable costs, and the Degree of Operating Leverage (DOL).
  • The ratios of fixed cost to total costs and fixed costs to variable costs tell us that if the unit variable cost is constant, then as sales increase, operating leverage decreases.

• Shut Down Case

  • If a firm decreased production it would still acquire variable costs not covered by revenue as well as fixed costs (costs inevitably incurred).
  • When determining whether to shutdown a firm has to compare the total revenue to the total variable costs.
  • If the revenue the firm is making is greater than the variable cost (R>VC) then the firm is covering it's variable costs and there is additional revenue to partially or entirely cover the fixed costs.
  • A firm that exits an industry does not earn any revenue, but is also does not incur fixed or variable costs.
  • Firms will produce as long as marginal revenue (MR) is greater than average total cost (ATC), even if it is less than the variable, or marginal cost (MC)

• Costs and Production in the Short-Run

  • Often the producer will know the costs at a few levels of output and must estimate or calculate the production function in order to make decisions about how many units of the variable input to use or altering the size of the plant (fixed input).
  • Variable Cost (VC) is the quantity of the variable input times the price of the variable input.
  • Sometimes VC is called total variable cost (TVC).
  • Average Variable Cost (AVC) is the VC divided by the output, AVC = VC/Q.
  • It is the variable cost per Q.

• Economic Costs

  • Total cost (TC): total cost equals total fixed cost plus total variable costs (TC = TFC + TVC) .
  • Variable cost (VC): the cost paid to the variable input.
  • Variable input is traditionally assumed to be labor.
  • Average variable cost (AVC): variable costs divided by output (AVC = TVC/q).
  • The average variable cost curve is normally U-shaped.

• Leverage Models

  • Operating leverage models include ratios, such as fixed costs to variable costs/total costs, fixed costs to income, and the DOL.
  • The variable cost per unit is $10.
  • The total fixed costs are $1,000.
  • Just as we interpret ratios of debt to equity and debt to total assets when analyzing financial leverage, when analyzing operating leverage, we can compare fixed costs to variable costs and fixed costs to total costs.
  • These ratios tell us that if the unit variable cost is constant, then as sales increase, operating leverage decreases.

• Short Run and Long Run Costs

  • Long run costs have no fixed factors of production, while short run costs have fixed factors and variables that impact production.
  • Fixed costs have no impact of short run costs, only variable costs and revenues affect the short run production.
  • Variable costs change with the output.
  • Examples of variable costs include employee wages and costs of raw materials.
  • The short run costs increase or decrease based on variable cost as well as the rate of production.

• Fixed Costs

  • This is in contrast to variable costs, which are volume-related and are paid per quantity produced.
  • In marketing, it is necessary to know how costs divide between variable and fixed.
  • In a survey of nearly 200 senior marketing managers, 60% responded that they found the "variable and fixed costs" metric very useful .
  • Average fixed cost is a per-unit-of-output measure of fixed costs.
  • This graph breaks down the difference between fixed costs and variable costs.

• Average and Marginal Cost

  • Marginal cost is the change in total cost when another unit is produced; average cost is the total cost divided by the number of goods produced.
  • Marginal cost is not related to fixed costs.
  • It is also equal to the sum of average variable costs and average fixed costs.
  • When the average cost declines, the marginal cost is less than the average cost.
  • When the average cost increases, the marginal cost is greater than the average cost.

• Cost-Based Pricing

  • Cost-based pricing is the act of pricing based on what it costs a company to make a product.
  • Cost-based pricing is the act of pricing based on what it costs a company to make a product.
  • Price = (1+ Percent Markup)(Unit Variable Cost + Average FixedCost) .
  • A company must know its costs.
  • Cost-based pricing is misplaced in industries where there are high fixed costs and near-zero marginal costs.